Softer growth amid increased uncertainty

Towards slower growth

“As good as it gets” seems to be the conclusion when looking at the IMF’s latest growth forecasts for the advanced economies: coming after 2.3% in 2017, they are for 2.4% this year and 2.1% next. Perhaps more important is the projection for 2023 of only 1.5% growth with 1.4% in both the US and the eurozone. For the US, this implies a quite significant cooling-off of the current overheated environment. “Overheated” applies in terms of a range of labor market indicators and certain asset prices, though not as far as wage growth and inflation are concerned. This allows the inflation- and growth-targeting Federal Reserve to proceed with its tightening cycle in a cautious, data-dependent way, which sustains investors’ large appetite for risk. The slowdown of next year and beyond is based on the waning impact of this year’s (unnecessary) fiscal boost, higher interest rates, the lagged effects of a stronger dollar, slower growth in corporate earnings, the impact of tariff increases (more inflation) and the retaliatory measures that hit exports. The ongoing tug of war with China on trade implies that risk is tilted to the downside.

Whereas the US is in a very mature stage of the business cycle, the position of the eurozone is less advanced. This should leave room for the expansion to continue despite the output gap that has finally been closed and an unemployment rate that has converged to its structural level. Indeed, growth of disposable income on the back of job creation and an acceleration of wage growth should support consumer spending whereas earnings growth, rising capacity utilization and easy access to financing create a favorable backdrop for corporate investment. However, cyclical dynamics have lost some momentum. Most sentiment indicators are now below their peaks registered towards the end of last year. The construction sector is an exception, and services are also holding up well. In manufacturing, however, the decline has been more pronounced. Nevertheless, considering the high baseline levels, current readings of survey indicators still correspond to above-potential GDP growth.

Protectionist threat, a major concern

Given the openness of the eurozone economy, the slowdown in world trade has acted as a headwind this year. It also implies significant exposure to the protectionist threat, which is now generally considered to be the major risk factor for the world economy: model-based simulations like the one in the IMF’s latest World Economic Outlook show that tariff increases and retaliatory measures end up creating a lose-lose situation. Moreover, even if eventually tariffs are not raised, the harm may have already been done. Worries that discussions between the US and the EU might fail help explain the significant increase of uncertainty among German corporates. Similarly, China, which is already confronted with a slowing economy, has faced tariff increases by the US and more may follow. This adds to the challenges of the authorities to boost domestic demand to compensate for weaker export growth.

Market nervousness adds to uncertainty

Slower growth in China doesn’t bode well for the country’s trading partners, in particular developing economies that have seen a decline in sentiment indicators. In addition, several of them have seen a depreciation of their currencies in recent months that through the impact on inflation, central bank tightening and higher bond yields, weighs on their growth outlook. Market nervousness has not been limited to developing economies. Indeed, in recent weeks, we have seen a pick-up in bond market and equity market volatility in the US that is reminiscent of the jump in volatility seen last February. Should this higher volatility last, it would be another factor that might end up weighing on the growth outlook.